Haircuts in Cyprus

No, I’m not referring to a trip to the barber in that sunny Mediterranean isle. But for those unfamiliar with the term, this seemingly innocuous word refers to the cuts and conditions that investors in Cypriot banks now have to face as part of the bailout plan to save the Cypriot economy. However, if you think that the Cypriot financial situation is as relevant to you as the chance of you getting an actual haircut in Cyprus, read on.

Our global village means that, to a greater or lesser degree, we all need to learn from the changing world economy. Investing is a crucial part of everyone’s financial plan. Our investments affect us constantly via our savings, whether we are actively investing directly in stocks, bonds and funds, or whether we are investing through our retirement savings plans, kranot hishtalmut and bank deposits.

There are numerous reasons to invest. They include people wanting to protect their money physically, and also to protect the value of their money while keeping up with inflation. Individuals want to ensure liquidity, save for retirement, or increase their current or future standard of living. Investing is practiced to increase a current or future standard of living, to generate income, or to reduce one’s overall financial risk. However, along with the potential growth and gain, there are multiple risks when investing. Risks include interest rates variability, company and industry risk, and asset classes or investment specific risk. But two types of risk that are not always recognized and properly evaluated are bank risk and country risk.

Most people tend to think that there is no risk associated with bank savings. Many people have the misconception that banks are large companies with huge vaults and high fees, that have an endless supply of money to pay back small and large depositors alike, with the total sum they deposited in their savings accounts. But banks are far from infallible. They are businesses that operate to make a profit and many times take risks that can lead to large losses. So when the Cyprus banking sector collapses causing all related parties (share and bond owners as well as depositors) to lose large amounts of money, it should not come as a complete surprise to anyone.

The following is a brief summary of what happened in Cyprus for those not reading the financial press. Essentially, Cyprian banks were restructured as a condition for the country receiving international aid to stave off complete countrywide bankruptcy. But instead of just the owners of the bank (i.e., stock and bond holders) being forced to accept large losses, depositors were also hit hard, with large depositors (over €100,000) losing over 60% of their money with the remaining approximately 40% remaining in a bank quickly losing its value. This new style “bail-in” where depositors are forced to literally pay the price of the bank and the country’s lack of financial responsibility, is threatening to become to new norm of banking rescues throughout Europe and the world. While banking collapses happen every so often (e.g. a few years back in Iceland), the significance of a European Union based country’s banks going under is much more serious, and the risk of runs on other banks throughout the continent has significantly increased. Unfortunately it can be the same with a country – which CAN go bankrupt. Without going into the intricate details of how and why it took place, the Cyprus banking sector and the entire economy were, and continue to be, in bad shape. The banks are basically bankrupt, the government is not able to support them, and so the country needed a bailout. It is unfortunately not a very rare occurrence to have a country go completely bankrupt and default on all their debts (e.g. Greece, Argentina, Russia …). The result in Cyprus was more than a week of bank holidays (when the banks were shut) and major open-ended currency restrictions (unlimited in nature at this time of writing), in addition to the large depositors losing significant sums of money as described above. While we tend to think that bank failures only happen in small, irrelevant countries, the USA itself has had hundreds of banks go bankrupt over the last five years. And while the FDIC (Federal Deposit Insurance Corporation) in the USA has protected a lot of savers from losing money, there have been no shortage of people who lost large sums of money.

Obviously there are serious implications for all of us in Israel. The crisis in Cyprus has affected many Israelis, who have lost significant sums of money. Although I have not yet seen it mentioned in the financial press, I know that, for decades, Cyprus has been a popular destination for Israelis setting up offshore trusts, given its proximity and ease of access to Israel. Cyprus will most likely cease to function as an offshore center that has catered over the years to Israelis because of its proximity.

So what can you do?

• Think about the stability of the financial institutions that you invest in – banks, investment houses, etc. The Israeli financial institutions are considered highly regulated, conservative and very strong financially and they have received the implicit backing of the government.

• Consider the countries where your money is located. • In which currency is the majority of your money? If it’s not in shekels and you don’t plan on spending money in that foreign currency, then you are taking the risk of a large currency devaluation that could affect your purchasing power. Especially considering that most Western central banks are printing money at unprecedented levels resulting in a race to devalue their respective currencies.

• Assess your ability to access your money and the possible time involved in doing so. While losses might be contained, the chances of limited future mobility of your savings are getting higher and growing monthly. In which case, how will you access your money in the future in the event of an emergency or, if and when your foreign bank decides to limit currency transfers abroad?

Don’t sit back, complacent in the irrelevance of haircuts in Cyprus. Take this financial disaster as a wakeup call, if you haven’t already done so. Risk cannot be eradicated, but it can certainly be reduced, and you can ensure that your hard-earned assets are as protected as possible.